Hotel and Resort Macroeconomic Outlook

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The hospitality industry is enjoying its 10th consecutive year of growth following the financial crisis and recession which erupted during the third quarter of 2008.  Dubbed the Great Recession, this era has been characterized by an unusually deep trough and prolonged time interval to recovery.  The cause for The Great Recession has been credited to deregulation in the financial industry, which allowed banks to engage in trading of complex and risky derivatives through the issuance of Collateralized Mortgage Backed Securities (CMBS) and exacerbated by a high default rate in the U.S. subprime home mortgage sector which was a biproduct of lax credit underwriting.  These events in turn precipitated a global economic crisis.

According to MaryJo Finocchiaro, Chief Financial Officer for BRE Hotels & Resorts, at this stage in the current cycle, optimism for perpetual gains is being replaced by caution. Nevertheless, she added that pundits agree the next economic downturn will be far milder and shorter in duration than what was suffered in 2008 or earlier recessions felt in 2004 following the dot.com crash and before that in 2001 post 9/11 tragedy.

At this stage in the current cycle, optimism for perpetual gains is being replaced by caution.

-MaryJo Finocchiaro, Executive VP and CFO

MaryJo said hotel upcycles typically last for no more than a decade before the industry encounters a period of softening in demand.  Socioeconomic and geopolitical events have also historically plagued the broader macroeconomic landscape in advance of a softening market, she pointed out.  MaryJo sited the current Trade War as an example which has created increased volatility and uncertainty, while she added that low unemployment continues to drive wage growth. Thisputs pressure on the hotel and resort industry given the significance of labor expense in relationship to total hotel operating costs.

In addition, she expressed that the Turner Construction Cost Index grew over five percent for the first nine months of 2019 which adversely impacts the cost of new build projects or enhancements to existing hotels and resorts.  The Turner Building Cost Index is determined by labor rates and productivity, material prices and the competitive condition of the marketplace.  Non-residential fixed investment also declined three percent for the quarter ended September 30, 2019 compared to a decrease of one percent for the second quarter of 2019.  At the same time, she added that interest rates have been decreasing from market dynamics and then reduced further by the Fed. MaryJo countered, noting unemployment remains at historical lows, personal income is strong and consumer spending was healthy for the third quarter of 2019 at close to three percent although down sequentially from the second quarter which posted +4.6%.  Also U.S. gross domestic product (GDP) posted above expectations during the third quarter at close to two percent but comping against nearly three percent for the third quarter last year she said.  She attributes the primary drivers to the quarter’s GDP growth to consumer spending, residential investment, and state and government spending.

MaryJo believes that market participants are largely in consensus that the hospitality industry will remain stable for the balance of 2019 while anticipating that 2020 will be characterized by moderating revenue growth compounded by a continued rise in operating costs – particularly labor expense, property insurance and real estate taxes.  She commented that M&A transactions are also expected to continue to be curbed because of unreconciled bid-ask gap between buyers and sellers during 2019 and 2020.  Though she remarked that the environment is ripe for hotel owners to refinance debt in order to free up equity in the backdrop of this low interest rate environment.

MaryJo thinks the industry is narrowing around an economic recession to originate and conclude in 2021.  She added that with the impact of the expected recession, the industry will likely see a dip in national housing starts given escalating construction costs.Resort capital spend is also expected to slow as well as broader business investment, new car sales will probably lag and of course other discretionary consumer spending including in hotels and resorts will decrease.  Money spent by consumers on non-essential purchases such as vacations and luxury items are the first hit by reduced demand in a tempering economy.  But she underscored that hotel owners are especially well poised to weather an impending recession.  Acquisition and lender underwriting have remained tight.  MaryJo concluded by saying she is bullish on the post-recession outlook conveying that hotel owners will undoubtedly benefit from opportunities created through the post-recession recovery.